Bernanke Battles `Big-Time’ Economic Erosion With New Rate Cuts

Less than three weeks after the Federal Reserve’s emergency interest-rate reduction was, in the words of its vice chairman, “overwhelmed” by the collapse of financial markets, Ben S. Bernanke is about to try again.

The outlook has worsened since the Fed last acted on Oct. 8, and analysts now say the economy may shrink more than 2 percent in the final quarter of 2008, its steepest decline in at least 18 years. “We’re heading south big-time,” says Lyle Gramley, a former Fed governor who is now senior economic adviser at Stanford Group Co. in Washington.

As a result, Fed Chairman Bernanke and his colleagues may eventually have to drive the benchmark overnight rate close to zero to resuscitate the economy. The next installment comes Oct. 29 when, says Gramley, “the Fed is going to cut rates a half percentage point.”

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That would reduce the central bank’s target for the federal funds rate, which commercial banks charge each other for overnight loans, to 1 percent. The official rate hasn’t been that low since 2004, and has never been lower since the Fed began trying to control it in the late 1980s. More cuts may follow if the economy doesn’t recover.

Bernanke, 54, and his colleagues are carrying out what Vincent Reinhart, former Fed director of monetary affairs, calls a “great monetary experiment” in attacking the financial crisis — and the credit crunch it spawned — on three fronts: lower rates, increased liquidity and purchases of assets that banks and investors don’t want.

A d v e r t i s e m e n t

A Worsening Economy

So far, they’ve had limited success in turning things around. In fact, the economy looks to be worsening and may shrink at an annual rate of 2.2 percent this quarter, based on the median of forecasts from 11 top economists in the last two weeks. That would come after a likely 0.5 percent contraction in the third quarter and would be the biggest decline since the fourth quarter of 1990, when the economy shrank by 3 percent.